ICBA - Publications - Fed's Stern Warns of Big Bank Risk

Fed's Stern Warns of Big Bank Risk

MAY 7, 2004


Federal Reserve Bank of Minneapolis president Gary Stern says the nation's largest banks have become increasingly complex, posing challenges for bank supervisors and serious long-term risks. In an interview with the Minneapolis Star-Tribune, Stern outlined his concerns and discussed the recent book, "Too Big to Fail: The Hazards of Bank Bailouts," he wrote with Minneapolis Fed vice president Ron Feldman.

Stern says in the 1980s only a few banks were too-big-to-fail but, as a result of industry consolidation, as many as 30 banks today would be too-big-to-fail. Stern says due to their implicit taxpayer backing, the largest banks are incurring unnecessary risk and engaging in increasingly complex activities, such as derivatives and securitized assets, that regulators do not fully understand.

"The seeds of serious bank problems are being sowed now," Stern told the Star-Tribune. "If risk-taking is priced too low, then somebody somewhere is taking on too much risk. And sooner or later, that will become evident."

To avoid taxpayer losses, Stern recommends reforms to large bank failure policy, such as closing large banks before they impose large losses, and requiring uninsured creditors and depositors to share in the loss even when the largest banks fail.

ICBA is skeptical that Stern's policy recommendations are workable. Precisely because of their size and systemic risk, regulators tend to coddle huge banks when they get in trouble in order to prevent their failure. And mandating that uninsured creditors accept at least some loss if not 100% will result in the same degree of panic, further precipitating failure.

As the mega-banks grow ever larger and more complex (we will soon have three banks of $1 trillion each), how can we expect anything other than systemic risk from their failure, with repercussions throughout our financial and economic system? In the face of such potentially dire consequences, policy makers are forced to take action to maintain confidence and stability for the benefit of all.

Nonetheless, ICBA applauds President Stern for highlighting the risks posed by mega-banks and unbridled industry concentration.